Defaulting on the Dream
States Respond to America’s Foreclosure Crisis

Few imaginable economic events send the same message of fear and foreboding in America as a housing crisis. For most Americans, their homes are their greatest asset. And for the states, industries dependent on housing are cornerstones for economic growth and fiscal stability.

Almost every state in the country has seen a significant increase in mortgage foreclosures, largely triggered by defaults on subprime mortgages. Yet greater challenges lay ahead. Based on new foreclosure projections by the Center for Responsible Lending, Pew estimates that one in 33 current U.S. homeowners will be in foreclosure, primarily in the next two years—the direct result of subprime loans made in 2005 and 2006. Among the states hardest hit are Nevada, where one in 11 homeowners could soon be in foreclosure; California, with one in 20; Florida, with one in 26, and Georgia, with one in 27.

In other states where the numbers are less severe, the situation is still troubling. If the economy tightens and home prices continue to fall, as many economists believe will be the case, more states and their residents will feel increasingly acute pain. The nation’s foreclosure crisis does not discriminate by region or size. In states such as Colorado, Indiana, Maryland, Michigan, Ohio, Oregon, Rhode Island, Tennessee and Texas, at least one in 37 homeowners is projected to experience foreclosure as a result of a subprime loan.

Nationally, about 3.3 million home mortgages may default in 2007 and 2008, and more than two million homeowners could lose their homes, according to Mark Zandi, Moody’s Economy.com’s chief economist, who testified before the U.S. House Housing Financial Services Committee in February 2008.¹ 

The effects reach far beyond a single house on a single block. Homeowners are estimated to lose $356 billion in home value because of nearby foreclosures, affecting nearly 40 million homes. The foreclosure problem also has spread to homeowners with prime loans— borrowers with solid credit histories. With home prices falling and credit tightening, prime borrowers are facing the same financial stress as those with subprime credit.

While this is a national crisis, states and local municipalities arguably will be asked to carry a larger share of the foreclosure burden as tax revenues decline and they experience increased demands for police and other services to deal with vacant and abandoned
properties.

A growing number of states have taken action, seeking at least to mitigate the damage to homeowners, lenders, municipalities and their own budgets. The severity and speed of the crisis have meant that, in many cases, states are experimenting with innovative but as yet unproven approaches. The jury is still out about whether and to what extent they will be effective. Still, several states among those hardest hit by foreclosures also have been among the most assertive in trying to address the problem.

These states are using a range of approaches to help residents at imminent risk of foreclosure from losing their homes. They are beefing up lending enforcement to prevent problematic loans from being made in the first place. And recognizing that the crisis demands a collaborative approach, they are bringing together all the major stakeholders, including lenders and representatives of the financial services market, to try to tackle the challenges comprehensively.

Ohio, for instance, launched a statewide campaign, including a 24-hour hotline, to encourage borrowers at risk of foreclosure to seek counseling. Ohio also sought involvement across the state to improve assistance for borrowers facing foreclosure, calling on lenders in the state to modify high-cost loans for homeowners. In early April, Governor Ted Strickland reached agreement with nine mortgage servicers on a significant effort to modify the terms of adjustable-rate subprime mortgages in Ohio. These and other actions sprang from a task force, created in March 2007 by the governor, that convened representatives from industry, government and the nonprofit sector to collaborate on policy recommendations.

Michigan now has two loan funds that help homeowners facing foreclosure, a statewide consumer education campaign and a task force; the state also requires greater disclosure of terms and conditions before a high-risk loan is made. California, which launched a task force last year, regulates mortgage brokers and high-risk loans and has issued a notice to loan servicers calling on them to agree to wholesale loan adjustments.

Although they had fewer loans in the foreclosure process as of December 2007, states such as Maryland and Massachusetts are taking similar steps, recognizing that they will face bigger problems if they do not act. Maryland recently passed sweeping emergency reforms, providing immediate help to distressed homeowners while strengthening the state’s oversight of the mortgage industry. It extended the foreclosure process from 15 to 150 days, criminalized mortgage fraud, banned prepayment penalties and is seeking to prevent deceptive foreclosure rescue transactions. Massachusetts soon will provide borrowers in default on their mortgage payments 90 days to work with their mortgage servicers to try to avoid foreclosure. In addition, the state recently made $2 million in grants available for foreclosure education, prevention and counseling initiatives.

Some states are contemplating more aggressive actions to delay foreclosure and its ripple effects on neighboring homes. In New York, legislators proposed a moratorium on foreclosures for one full year. Massachusetts, Minnesota and New Jersey have proposed six-month deferments of foreclosures, with Minnesota and New Jersey’s proposals including some form of rent-back or partial payment from the delinquent borrower. These proposals to place longterm moratoria on foreclosures face steep industry opposition, but they highlight the pressure states are under to try to address the current crisis.

But given the scale of the crisis and the complexity of today’s mortgage markets, states cannot go it alone, and it makes little sense to have 50 separate and specific responses. There is broad agreement that the federal government should take a strong leadership
role. As it considers a range of proposals, both to help more homeowners stave off foreclosure and to strengthen underwriting standards, Congress should understand what states already are doing and how its policy choices will affect those efforts. It also should ensure that states have flexibility to pursue measures that respond to their particular circumstances and needs and build on, rather than pre-empt, those actions that go the furthest in protecting homeowners from practices that undermine wise and responsible borrowing choices.

We have based our findings in this report on data and analysis that are comparable to information from well respected industry analysts such as First American, Lehman Brothers, Merrill Lynch, Credit Suisse and Moody’s Economy.com. We rely on the Mortgage Bankers Association’s National Delinquency Survey to highlight foreclosure challenges at the end of December 2007. In addition, we use the Center for Responsible Lending’s projections to draw attention to the estimated number of foreclosures and ripple effects from subprime loans made in 2005 and 2006. However, as any researcher will note, these data have limitations; for a more detailed description of our methodology, see page 6.²

We have used the best available data to describe the challenges that our nation and states may face. But the current policy debate has been limited by the lack of data on the actual number of loans that have ended in foreclosure. Policy makers need accurate, comprehensive and up-to-date information to fully understand their foreclosure problems and identify potential solutions. States have an important role to play here, and many are already building systems that link property descriptions, mortgage information and foreclosure actions. However, having 50 idiosyncratic foreclosure databases is not a solution. Instead, Congress and the states should consider ways to collect, maintain and share reliable and uniform information across all 50 states to more accurately describe current conditions and better assess the effectiveness of policy interventions.